The long rise in profits is mostly just the flip side of falling interest rates

Here’s a deeply misleading chart:

It would appear that the returns to owning capital have grown far in excess of national income. More than a seventh of all the money earned in America has gone to equity owners in the past few years, nearly double the proportion in the 1980s.

Nostalgists for the 1960s and 1970s might see this as evidence that structural changes since the 1980s mainly benefited the wealthy at the expense of regular people. Some have argued, for example, that the growth of the lobbyist-regulatory state has dampened competition and boosted aggregate profitability.

While those sorts of arguments probably explain the performance of particular companies or even entire sectors, the logic doesn’t hold up when expanded to consider the profitability of private enterprise as a whole.

In fact, the data show rising returns to equity owners have largely come at the expense of creditors, not workers or the indigent. Capital income as a whole hasn’t changed much as a share of the total. Instead, interest payments paid by businesses have plunged, and the extra money has been returned to shareholders.

The chart below from shows profits by type and net interest payments since 1947. This broader measure of capital income has been remarkably stable since the data begin:

(Both charts so far are based on tables 1.10 and 1.13 of the National Income and Product Accounts. Note that rental income and interest payments both exclude owner occupiers in the household sector. Please read Alphaville’s earlier explanation for more detail on the relationship between “imputed” rental income and mortgage interest rates.)

Since the peak in 1984, net interest payments made by businesses fell by 3.2 percentage points of gross domestic income. Over the same period, profits earned by partnerships and sole proprietors grew by about 1.8 percentage points of GDI, after-tax corporate profits grew by 1 per cent of GDI, and the earnings of people renting out homes to tenants grew by 0.3 percentage points of GDI.

Even more detail can be gathered by looking at the interest paid and profits earned by different types of companies. Among nonfinancial corporate businesses, for example, the combined amount earned in profits and paid to creditors has been remarkably stable as a share of gross domestic income over time. Via table 1.14 of the NIPAs:

Since the start of 1990, after-tax profits of nonfinancial corporations grew by about 1.8 percentage points of national income, while net interest paid by those same businesses dropped by 1.3 percentage points. (The numbers look a bit different if you switch the denominator from gross domestic income to gross value added by nonfinancial corporations, but not by much.)

Looking further back, it’s plausible corporate profitability would be lower if not for changes in tax rates and the ease with which large American firms can shift earnings to places where they don’t owe tax. After all, the average effective tax rate on corporate profits has plunged by nearly 20 percentage points since the 1950s:

But much of the decline in the effective tax rate was offset by the decline in interest that could be deducted. The result was a transfer from creditors to shareholders and taxpayers, rather than a transfer from taxpayers to shareholders.

This can be seen in the chart below, which shows the total amount of corporate taxes paid as a share of gross domestic income since 1982:

Aside from normal cyclical swings, the effective corporate tax take has been remarkably stable.

Changes in tax policy might be expected to have had a bigger impact on the profits of proprietors and partnerships, but even there, about half of the modest increase in this form of income since the early 1980s as a share of national income can be explained by falling interest burdens:

The rising share of American income coming from business profits may be cause for concern, but only insofar as it reflects how changes in interest rates have made it harder to eke out a living from holding fixed income. Conversely, anyone who thinks interest rates are going to rise significantly should probably be concerned about the outlook for business profits.

Related links:
Americans are making more money from renting out homes than ever before, sort of — FT Alphaville
The changing nature of Americans’ income — FT Alphaville